WEB CHAPTER 29—BASIC FINANCIAL TOOLS
232. Your business has just taken out a 1-year installment loan for $72,500 at a nominal rate of 11.0% but with equal end-
of-month payments. What percentage of the 2nd monthly payment will go toward the repayment of principal?
a.
73.67%
b.
77.55%
c.
81.63%
d.
85.93%
e.
90.45%
e
Amortization
233. On January 1, 2016, your sister’s pet supplies business obtained a 30-year amortized mortgage loan for $250,000 at a
nominal annual rate of 7.0%, with 360 end-of-month payments. The firm can deduct the interest paid for tax purposes.
What will the interest tax deduction be for 2016?
a.
$17,419.55
b.
$17,593.75
c.
$17,769.68
d.
$17,947.38
e.
$18,126.85
a
WEB CHAPTER 29—BASIC FINANCIAL TOOLS
234. You borrowed $50,000 which you must repay in 10 years. You plan to make an initial deposit today, then make 9
more deposits at the beginning of each the next 9 years, but with the deposits increasing at the inflation rate. You expect
to earn 5% on your funds, and you expect a 3% inflation rate. To the nearest dollar, how large must your initial deposit be
to enable you to reach your $50,000 target?
a.
$3,008
b.
$3,342
c.
$3,676
d.
$4,044
e.
$4,448
WEB CHAPTER 29—BASIC FINANCIAL TOOLS
235. Your 75-year-old grandmother expects to live for another 15 years. She currently has $1,000,000 of savings, which is
invested to earn a guaranteed 5% rate of return. If inflation averages 2% per year, how much can she withdraw (to the
nearest dollar) at the beginning of each year and keep the withdrawals constant in real terms, i.e., growing at the same rate
as inflation and thus enabling her to maintain a constant standard of living?
a.
$65,632
b.
$72,925
WEB CHAPTER 29—BASIC FINANCIAL TOOLS
c.
$81,027
d.
$89,130
e.
$98,043
c
prove that this value “works” to within one penny.
2.
Click Tools>Goal Seek to get a dialog box, which you then fill out as
WEB CHAPTER 29—BASIC FINANCIAL TOOLS
236. Julian and Jonathan are twin brothers (and so were born on the same day). Today, both turned 25. Their grandfather
began putting $2,500 per year into a trust fund for Julian on his 20th birthday, and he just made a 6th payment into the
fund. The grandfather (or his estate’s trustee) will make 40 more $2,500 payments until a 46th and final payment is made
on Julian’s 65th birthday. The grandfather set things up this way because he wants Julian to work, not be a “trust fund
baby,” but he also wants to ensure that Julian is provided for in his old age.
Until now, the grandfather has been disappointed with Jonathan and so has not given him anything. However, they
recently reconciled, and the grandfather decided to make an equivalent provision for Jonathan. He will make the first
payment to a trust for Jonathan today, and he has instructed his trustee to make 40 additional equal annual payments until
Jonathan turns 65, when the 41st and final payment will be made. If both trusts earn an annual return of 8%, how much
must the grandfather put into Jonathan‘s trust today and each subsequent year to enable him to have the same retirement
Difficulty: Challenging
INTE.GENE.16.204 – LO: 29-1
United States – BUSPROG: Analytic
United States – TN – DISC: Time value of money
United States – OH – Default City – TBA
Growing annuity
Bloom’s: Application
TYPE: Multiple Choice: Problem
WEB CHAPTER 29—BASIC FINANCIAL TOOLS
nest egg as Julian after the last payment is made on their 65th birthday?
a.
$3,726
b.
$3,912
c.
$4,107
d.
$4,313
e.
$4,528
a
237. You plan to work for Strickland Corporation for 12 years after graduation and after that want to start your own
business. You expect to save and deposit $7,500 a year for the first 6 years (t = 1 through t = 6) and $15,000 annually for
the following 6 years (t = 7 through t = 12). The first deposit will be made a year from today. In addition, your
grandmother just gave you a $25,000 graduation gift that you will deposit immediately (t = 0). If the account earns 9%
compounded annually, how much will you have when you start your business 12 years from now?
a.
$238,176
b.
$250,712
c.
$263,907
d.
$277,797
e.
$291,687
WEB CHAPTER 29—BASIC FINANCIAL TOOLS
238. You are in negotiations to make a 7-year loan of $25,000 to DeVille Corporation. To repay you, DeVille will pay
$2,500 at the end of Year 1, $5,000 at the end of Year 2, and $7,500 at the end of Year 3, plus a fixed but currently
unspecified cash flow, X, at the end of each year from Year 4 through Year 7. You are confident the payments will be
made, since DeVille is essentially riskless. You regard 8% as an appropriate rate of return on a low risk but illiquid 7-year
loan. What cash flow must the investment provide at the end of each of the final 4 years, that is, what is X?
a.
$4,271.67
b.
$4,496.49
c.
$4,733.15
d.
$4,969.81
e.
$5,218.30
c
WEB CHAPTER 29—BASIC FINANCIAL TOOLS
239. Scott and Linda have been saving to pay for their daughter Casie’s college education. Casie just turned 10 at (t = 0),
and she will be entering college 8 years from now (at t = 8). College tuition and expenses at State U. are currently $14,500
a year, but they are expected to increase at a rate of 3.5% a year. Ellen should graduate in 4 years⎯if she takes longer or
wants to go to graduate school, she will be on her own. Tuition and other costs will be due at the beginning of each school
year (at t = 8, 9, 10, and 11).
So far, Scott and Linda have accumulated $15,000 in their college savings account (at t = 0). Their long-run financial plan
is to add an additional $5,000 in each of the next 4 years (at t = 1, 2, 3, and 4). Then they plan to make 3 equal annual
contributions in each of the following years, t = 5, 6, and 7. They expect their investment account to earn 9%. How large
must the annual payments at t = 5, 6, and 7 be to cover Casie’s anticipated college costs?
a.
$1,965.21
b.
$2,068.64
c.
$2,177.51
d.
$2,292.12
e.
$2,412.76
e
WEB CHAPTER 29—BASIC FINANCIAL TOOLS
240. Stuart Company’s manager believes that economic conditions during the next year will be strong, normal, or weak,
and she thinks that the firm’s returns will have the probability distribution shown below. What’s the standard deviation of
the estimated returns? (Hint: Use the formula for the standard deviation of a population, not a sample.)
Economic
Conditions
Prob.
Return
Strong
30%
32.0%
WEB CHAPTER 29—BASIC FINANCIAL TOOLS
Normal
40%
10.0%
Weak
30%
−16.0%
a.
17.69%
b.
18.62%
c.
19.55%
d.
20.52%
e.
21.55%
241. The $10.00 million mutual fund Henry manages has a beta of 1.05 and a 9.50% required return. The risk-free rate is
4.20%. Henry now receives another $5.00 million, which he invests in stocks with an average beta of 0.65. What is the
required rate of return on the new portfolio? (Hint: You must first find the market risk premium, then find the new
portfolio beta.)
a.
8.83%
b.
9.05%
c.
9.27%
d.
9.51%
e.
9.74%
a
WEB CHAPTER 29—BASIC FINANCIAL TOOLS
242. Hazel Morrison, a mutual fund manager, has a $40 million portfolio with a beta of 1.00. The risk-free rate is 4.25%,
and the market risk premium is 6.00%. Hazel expects to receive an additional $60 million, which she plans to invest in
additional stocks. After investing the additional funds, she wants the fund’s required and expected return to be 13.00%.
What must the average beta of the new stocks be to achieve the target required rate of return?
a.
1.68
b.
1.76
c.
1.85
d.
1.94
e.
2.04
WEB CHAPTER 29—BASIC FINANCIAL TOOLS
243. Joel Foster is the portfolio manager of the SF Fund, a $3 million hedge fund that contains the following stocks. The
required rate of return on the market is 11.00% and the risk-free rate is 5.00%. What rate of return should investors expect
(and require) on this fund?
Stock
Amount
Beta
A
$1,075,000
1.20
B
675,000
0.50
C
750,000
1.40
D
500,000
0.75
$3,000,000
a.
10.56%
b.
10.83%
c.
11.11%
d.
11.38%
e.
11.67%
ANSWER:
c
POINTS:
DIFFICULTY:
Difficulty: Challenging
INTE.GENE.16.206 – LO: 29-3
United States – BUSPROG: Analytic
United States – TN – DISC: Risk and return
United States – OH – Default City – TBA
TOPICS:
Port. beta and req. ret.
KEYWORDS:
Bloom’s: Application
OTHER:
TYPE: Multiple Choice: Problem
INTE.GENE.16.206 – LO: 29-3
United States – BUSPROG: Analytic
United States – TN – DISC: Risk and return
United States – OH – Default City – TBA
TOPICS:
Portfolio beta
KEYWORDS:
Bloom’s: Application
OTHER:
TYPE: Multiple Choice: Problem
WEB CHAPTER 29—BASIC FINANCIAL TOOLS
244. DHF Company has a beta of 1.5 and is currently in equilibrium. The required rate of return on the stock is 12.00%
versus a required return on an average stock of 10.00%. Now the required return on an average stock increases by 30.0%
(not percentage points). Neither betas nor the risk-free rate change. What would DHF’s new required return be?
a.
14.89%
b.
15.68%
c.
16.50%
d.
17.33%
e.
18.19%
c
245. McGaha Enterprises expects earnings and dividends to grow at a rate of 25% for the next 4 years, after the growth
rate in earnings and dividends will fall to zero, i.e., g = 0. The company’s last dividend, D0, was $1.25, its beta is 1.20, the
market risk premium is 5.50%, and the risk-free rate is 3.00%. What is the current price of the common stock?
a.
$26.77
b.
$27.89
c.
$29.05
d.
$30.21
e.
$31.42
WEB CHAPTER 29—BASIC FINANCIAL TOOLS
246. Orwell building supplies’ last dividend was $1.75. Its dividend growth rate is expected to be constant at 25% for 2
years, after which dividends are expected to grow at a rate of 6% forever. Its required return (rs) is 12%. What is the best
estimate of the current stock price?
a.
$41.58
b.
$42.64
c.
$43.71
d.
$44.80
e.
$45.92
c
WEB CHAPTER 29—BASIC FINANCIAL TOOLS
247. The last dividend paid by Wilden Corporation was $1.55. The dividend growth rate is expected to be constant at
1.5% for 2 years, after which dividends are expected to grow at a rate of 8.0% forever. The firm’s required return (rs) is
12.0%. What is the best estimate of the current stock price?
a.
$37.05
b.
$38.16
c.
$39.30
d.
$40.48
e.
$41.70
ANSWER:
a
RATIONALE:
Last dividend (D0)
$1.55
Short-run growth rate
1.50%
Long-run growth rate
8.00%
Required return
12.00%
Year
0
1
2
3
1.50%
1.50%
8.00%
Dividend
$1.5500
$1.5733
$1.5968
$1.7246
Terminal value = D3/(rs − g3)
=
43.1149
Total CFs
$1.5733
$44.7118
PV of CFs
$1.4047
$35.6439
Price = Sum of PVs = $37.05
POINTS:
DIFFICULTY:
TOPICS:
KEYWORDS:
OTHER:
248. The last dividend paid by Coppard Inc. was $1.25. The dividend growth rate is expected to be constant at 15% for 3
years, after which dividends are expected to grow at a rate of 6% forever. If the firm’s required return (rs) is 11%, what is
PV of CFs
$1.9531
$40.6901
Price = Sum of PVs = $42.64
POINTS:
DIFFICULTY:
TOPICS:
KEYWORDS:
OTHER:
WEB CHAPTER 29—BASIC FINANCIAL TOOLS
its current stock price?
a.
$30.57
b.
$31.52
c.
$32.49
d.
$33.50
e.
$34.50
Difficulty: Challenging
INTE.GENE.16.207 – LO: 29-4
United States – BUSPROG: Analytic
United States – TN – DISC: Stocks and bonds
United States – OH – Default City – TBA
Nonconstant growth valuation
Bloom’s: Application
TYPE: Multiple Choice: Problem
249. Sawchuck Consulting has been profitable for the last 5 years, but it has never paid a dividend. Management has
indicated that it plans to pay a $0.25 dividend 3 years from today, then to increase it at a relatively rapid rate for 2 years,
and then to increase it at a constant rate of 8.00% thereafter. Management’s forecast of the future dividend stream, along
with the forecasted growth rates, is shown below. Assuming a required return of 11.00%, what is your estimate of the
stock’s current value?
Year
0
1
2
3
4
5
6
Growth rate
NA
NA
NA
NA
50.00%
25.00%
8.00%
Dividends
$0.000
$0.000
$0.000
$0.250
$0.375
$0.469
$0.506
a.
$9.94
b.
$10.19
c.
$10.45
d.
$10.72
e.
$10.99
WEB CHAPTER 29—BASIC FINANCIAL TOOLS